2016 (9) TMI 907 - AT - Income Tax

Royalty Payments: Independent Comparables Key for Arm's Length Price

The Tribunal remanded the case to the Assessing Officer for proper benchmarking analysis of royalty payments in license agreements. It emphasized the ... Arm's Length Price - Benchmarking of international transactions - Royalty for use of trademark versus transfer of technology - RBI/FIPB approval not determinative of ALP - Onus of proof on the assessee - Comparable Uncontrolled Price (CUP) principleRBI/FIPB approval not determinative of ALP - Arm's Length Price - Onus of proof on the assessee - Whether governmental approvals (RBI/FIPB/DIPP) and their prescribed royalty rates are determinative of the Arm's Length Price for royalty payments. - HELD THAT: - The Tribunal held that approvals granted by RBI/FIPB/DIPP serve purposes such as foreign exchange management and promotion of industry and are not intended to determine the Arm's Length Price under transfer pricing provisions. Such approvals cannot be equated with an independent Comparable Uncontrolled Price or a determinative benchmark for ALP. The Tribunal reiterated the settled proposition that the onus lies on the assessee to prove that international transactions are at arm's length and that the assessee must independently benchmark royalty payments using appropriate comparables and methods under the transfer pricing rules. The Tribunal noted that the TPO's reliance on Press Note 9(2000) to restrict royalty to 1% related to trademark-only payments, but nevertheless affirmed the principle that statutory/administrative approvals do not supplant the need for transfer pricing comparability analysis. [Paras 12]Approvals of RBI/FIPB/DIPP are not determinative of ALP; the onus to prove arm's length rests with the assessee and requires independent benchmarking.Benchmarking of international transactions - Royalty for use of trademark versus transfer of technology - Comparable Uncontrolled Price (CUP) principle - Determination of ALP for the royalty paid to the associated enterprise and whether the royalty payment should be restricted without independent comparables. - HELD THAT: - The Tribunal found that the assessee had not performed a separate benchmarking analysis of the royalty transaction at the time of filing Form 3CEB or in its transfer pricing documentation. Although the revenue authorities applied Press Note 9(2000) to restrict the royalty, the Tribunal observed that relevant clauses of the trademark licence agreement had not been adequately appreciated by the revenue. In the interests of justice and fair play, the Tribunal refrained from finally adjudicating the ALP on the record before it because the comparability analysis, which is the substratum for determining ALP, was absent. Consequently, the matter was directed to be restored to the file of the Assessing Officer to require the assessee to benchmark the royalty transaction with independent comparables using suitable methods prescribed under the Act; the AO is to decide the issue thereafter after giving the assessee adequate opportunity. [Paras 12, 13]Issue remanded to the Assessing Officer for fresh benchmarking and determination of ALP for the royalty payment with independent comparables and appropriate TP methods.Final Conclusion: The Tribunal held that statutory or administrative approvals (RBI/FIPB/DIPP) do not determine ALP and that the assessee bears the onus of independent benchmarking; accordingly the matter of determining arm's length royalty was remanded to the Assessing Officer for fresh consideration after proper comparability analysis. Appeal allowed for statistical purposes. Issues:1. Interpretation of royalty payment terms in license agreements.2. Benchmarking analysis for royalty payments.3. Relevance of government approvals for transfer pricing purposes.Issue 1: Interpretation of royalty payment terms in license agreementsThe appellant, engaged in manufacturing and sale of products, entered into a license agreement for the use of knowhow, formulae, and trademarks. The agreement was extended with approval from regulatory bodies. The Transfer Pricing Officer (TPO) restricted royalty payment to 1% based on a press note, as the appellant failed to provide comparable license agreements. The Commissioner of Income Tax (Appeals) upheld the decision, stating that the approvals obtained were for manufacturing/collaboration, not specifically for trademark use. The appellant argued that the agreement involved technology transfer, not just trademark use. The Tribunal found that the appellant did not independently benchmark the royalty transaction, as required by law. The case was remanded to the Assessing Officer for proper benchmarking analysis.Issue 2: Benchmarking analysis for royalty paymentsThe appellant relied on government approvals for royalty payment benchmarking, but the TPO and CIT(A) emphasized the lack of independent comparables. The Tribunal noted that the appellant did not benchmark royalty payment separately, leading to the application of a 1% restriction by the TPO. The RBI approval was deemed irrelevant for determining Arm's Length Price (ALP). The Tribunal highlighted the necessity for independent benchmarking to establish ALP, citing the Punjab & Haryana High Court's decision. The approval rates by DIPP and RBI were deemed for different purposes and not indicative of ALP. The Tribunal directed the appellant to benchmark the royalty transaction with independent comparables following TP regulations.Issue 3: Relevance of government approvals for transfer pricing purposesThe Tribunal clarified that government approvals for royalty payments do not determine ALP and cannot serve as valid Comparable Uncontrolled Price (CUP). The approvals are granted for ease of business and foreign exchange management, not for ALP determination. The Tribunal emphasized the need for independent benchmarking to establish ALP, as mandated by TP provisions. The case was remanded to the Assessing Officer for proper benchmarking analysis to determine the arm's length price for royalty payments.In conclusion, the Tribunal allowed the appeal for statistical purposes, directing the appellant to conduct proper benchmarking analysis for royalty payments with independent comparables to determine the arm's length price in accordance with transfer pricing regulations.